LONDON - Earlier this month Michael Glos, Germany's economy minister warned his peers at the Bundestag that "clouds [were] gathering in the economic sky." On Tuesday it looked like Europe's biggest economy was starting to feel the first drops of rain.
A closely watched survey showed that German business confidence had dropped for the fourth month in a row, and more sharply than expected. The monthly index compiled by the Ifo Institute for Economic Research at the University of Munich, which questions 7,000 business executives, fell to 104.2 points this month, from 105.8 points in August. Economists had expected a smaller drop to 105.0.
The main concerns appear to have revolved around three issues: the relentless rise of the euro against the dollar, a rise in oil prices, and financial market turmoil caused by mistrust between banks over investment exposure to America's subprime mortgage troubles. A hoarding of cash by banks will make it increasingly difficult for companies and consumers to borrow money.
The trend lower suggested "a permanent change of course" for the German economy, Commerzbank analyst Ralph Solveen said. "We expect the German economy to lose further steam in the coming quarters," he added.
"This does argue for a peak in the economic cycle," Global Insight economist Timo Klein told. Economic growth in Germany had long been expected to slow in the first half of 2007 because of an increase in value added tax (VAT) to 19%, from 16%, on most goods. But Klein said he expected the Ifo to continue to show waning confidence in the coming months, at least until there is a recovery in the financial markets.
Hans-Werner Sinn the president of the Ifo, said in a statement on the institute's Web site that Germany was seeing the first signs of a slowdown in the economy, to which "events in the financial markets are likely to have contributed."
"Companies are assessing their current situation less positively than in August," he added, with the business climate among retailers having "markedly worsened," because they had a "less favorable assessment of the current situation." Germany's retailers have been hit by the recent spike in food and oil prices.
Sinn spoke of "moderate optimism" in Germany's manufacturing sector and said the business climate in the construction industry had cooled off. Hiring among all the survey's participants was expected to slow down.
The subprime infection has already hit European banks hard--yesterday one analyst said that Deutsche Bank's third quarter profit could be hit by up to $2 billion because of the current liquidity crisis.
Last week's 0.5% cut in interest rates by the United States Federal Reserve has certainly helped calm the turmoil in the markets, as evidenced in a drop of credit spreads. But the euro has climbed to several new highs this month and is expected to breach the $1.45 barrier before the end of the year.
Germany has emerged from stagnation to experience a mini-economic renaissance over the last two years, largely thanks to stronger exports. But a stronger euro, coupled with rising labor costs, could dent the revenues of carmakers like Volkswagen, Bayerische Motoren Werke and DaimlerChrysler, along with other exporters.
Germany's monthly ZEW survey of German investor confidence also recently showed a bigger-than-expected drop for the fourth consecutive month.
"Without a doubt, the mixture of high uncertainty about the fallout of the subprime crisis on the real economy and the new record highs in the oil price as well as the euro-dollar exchange rate... dampened the solid business outlook of firms," UniCredit ecibinust Alexander Koch said.
"If money market conditions calmd down say by November, the overall effect on the economic will not be so strong," Koch added. "The longer it lasts the larger the impact will be."